Is Shanghai Aohua Photoelectricity Endoscope Co., Ltd.'s (SHSE:688212) Recent Price Movement Underpinned By Its Weak Fundamentals?

With its stock down 24% over the past three months, it is easy to disregard Shanghai Aohua Photoelectricity Endoscope (SHSE:688212). It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. Particularly, we will be paying attention to Shanghai Aohua Photoelectricity Endoscope's ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Shanghai Aohua Photoelectricity Endoscope

How To Calculate Return On Equity?

ROE can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Shanghai Aohua Photoelectricity Endoscope is:

3.3% = CN¥47m ÷ CN¥1.4b (Based on the trailing twelve months to March 2024).

The 'return' is the amount earned after tax over the last twelve months. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.03 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Shanghai Aohua Photoelectricity Endoscope's Earnings Growth And 3.3% ROE

It is hard to argue that Shanghai Aohua Photoelectricity Endoscope's ROE is much good in and of itself. Even compared to the average industry ROE of 7.4%, the company's ROE is quite dismal. Thus, the low net income growth of 3.3% seen by Shanghai Aohua Photoelectricity Endoscope over the past five years could probably be the result of it having a lower ROE.

We then compared Shanghai Aohua Photoelectricity Endoscope's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 7.0% in the same 5-year period, which is a bit concerning.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Shanghai Aohua Photoelectricity Endoscope is trading on a high P/E or a low P/E, relative to its industry.

Is Shanghai Aohua Photoelectricity Endoscope Making Efficient Use Of Its Profits?

While Shanghai Aohua Photoelectricity Endoscope has a decent three-year median payout ratio of 50% (or a retention ratio of 50%), it has seen very little growth in earnings. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

In addition, Shanghai Aohua Photoelectricity Endoscope only recently started paying a dividend so the management must have decided the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 17% over the next three years. As a result, the expected drop in Shanghai Aohua Photoelectricity Endoscope's payout ratio explains the anticipated rise in the company's future ROE to 12%, over the same period.

Conclusion

In total, we're a bit ambivalent about Shanghai Aohua Photoelectricity Endoscope's performance. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com